Tag Archives: #china

Support They Withdrew

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Elections across the EU
Showed people there no longer view
The powers that be
As able to see
Their woes, so support they withdrew

The weekend saw the conclusion of the EU elections which resulted in a significant change in the political landscape there. No longer do the two centrist parties represent a majority but rather, huge gains were made by more extreme nationalist parties in almost every country. For example, in the UK, the Brexit party dominated, winning >30% of the vote, with both Tories and Labour losing significant share. In Germany, Chancellor Merkel’s Christian Democrats saw their vote share decline dramatically, well below 30%, and in France, President Macron’s party lost out to the National Front’s Marine Le Pen. It appears that there is a great deal of anxiety afoot in the EU, which of course is only enflamed by the imminent (?) exit of the UK.

But getting trounced in EU elections is not nearly enough to stop those currently holding power in individual country governments from changing their ways, this much is clear. As evidence I point to the process for selecting the new leadership of the ECB, the European Commission and the European Council, which will continue to be managed according to the old rules of country size combined with the recentness of those nations holding one of the seats. The point is that while thus far there has been some lip service paid to the changes afoot, the entrenched political class are not about to give up their positions without a fight.

It is with this in mind that I continuously view the euro with such skepticism. Not only are individual countries riven, but the broad leadership seems unwilling to accept that the world is different than when the EU was formed. For now, markets continue to view the situation as tenable but weakening. And given the lack of fiscal policy initiatives across the bloc, (except for Italy which is on the road to getting penalized for them), currency values remain beholden to monetary policy efforts. With that in mind, all eyes will be on the ECB meeting next week when the latest economic forecasts are presented. Recent data has shown that surveys point to further weakness, but domestic consumption has held up well across most of the nations using the euro. However, given the clear slowdown being seen in both the US and China, it is difficult to believe that the ECB will sound remotely hawkish. I expect that the new TLTRO’s will have very favorable terms as Signor Draghi will do everything he can to goose the economy before he leaves in October. And despite the growing call for looser policy in the US, I expect the dollar to maintain its current strength.

In China a small bank went bust
And traders are losing their trust
The PBOC
Can preempt the spree
Of weakness that pundits discussed

The other interesting news over the weekend was that the PBOC assumed control of Baoshang Bank, a small lender that turned out to be highly overextended with off balance sheet transactions. This is the first time in more than 20 years this has been necessary, and the market impacts were mostly as one would expect. Shares in other small banks suffered, the PBOC injected ~$20 billion into the system to help offset some of the pressure and the yuan fell a further 0.25%. The one mild surprise was that the Shanghai Composite actually closed higher on the day, but that was in response to the new PBOC liquidity. Chinese data remains suspect and there is no evidence that anything regarding the US-China trade situation has improved since last week’s split. While the Chinese continue to claim they will maintain a stable currency, the pressure continues to build for the yuan to weaken further.

Away from those two stories, the wires have been relatively quiet. The dollar is firmer across the board this morning, rising about 0.2% uniformly, as risk continues to be reduced by investors around the world. Treasury yields have fallen back below 2.30% in the 10-year, while similar duration Bunds traded as low as -0.16% before edging back to their current -0.14% level. European equity markets are soft, albeit not collapsing, and US equity futures are pointing to a lower opening. The data to be released this week is relatively limited which means that markets are going to be looking for subtler clues from the central banking community for the next directional trends.

Today Case-Shiller Home Prices 2.6%
  Consumer Confidence 130.0
Thursday Initial Claims 215K
  Q2 GDP (2nd look) 3.1%
  Goods Trade Balance -$72.0B
Friday Personal Income 0.3%
  Personal Spending 0.2%
  Core PCE 0.2% (1.6% Y/Y)
  Chicago PMI 53.7
  Michigan Sentiment 101.5

We have a much less active Fed speaker calendar with just two, Clarida and Williams, but given the overall consistency of what we have heard lately, i.e. patience is the proper policy but the possibility of easing has not been ruled out, unless one of these two sounds highly dovish, I don’t expect much response. The week is setting up to focus on Thursday and Friday’s data, as well as waiting to hear about the next steps on Brexit or European leadership. It seems for now that the trade story has moved to the back burner. Given all this, it is hard to get excited about pending movement in the dollar, and I imagine that barring a self-induced market sell-off, there will be little of note ongoing this week with the dollar remaining in a fairly tight range.

Good luck
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Completely Dissolved

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The last time the FOMC
Sat down to discuss policy
The trade talks were purring
While folks were concurring
A hard Brexit never could be

But since then the world has evolved
And good will completely dissolved
So what they discussed
They now must adjust
If problems are e’er to be solved

It wasn’t too long ago that the Fed was the single most important topic in markets. Everything they said or did had immediate ramifications on stocks, bonds and currencies. In some circles, the Fed, and their brethren central banks, were seen as omnipotent, able to maintain growth by simply willing it higher. A natural consequence of that narrative was that the FOMC Minutes especially, but generally those of all the major central banks, were always seen as crucial in helping to better understand the policy stance, as well as its potential future. But that time has passed, at least for now. Yesterday’s FOMC Minutes were, at best, the third most important story of the day mostly because they opened the window on views that are decidedly out of date. Way back then, three weeks ago, the backdrop was of a slowly resolving trade dispute between the US and China with a deal seeming imminent, growing confidence that a no-deal Brexit was out of the picture, and an equity market that was trading at all-time highs. My how quickly things can change!

To summarize, the Minutes expressed strong belief amongst most members that patience remained the proper stance for now, although a few were concerned about too low inflation becoming more ingrained in the public mind. And then there was a technical discussion of how to manage the balance sheet regarding the tenors of Treasury securities to hold going forward, whether they should be focused in the front end, or spread across the curve. However, no decisions were close to being made. It should be no surprise that the release had limited impact on markets.

The thing is, over the past few sessions we have heard an evolution in some FOMC members’ stance on things, specifically with Bullard and Evans discussing the possibility of cutting rates, although as of now, they are the only two. However, we have heard even some of the more hawkish members willing to imply that rate cuts could be appropriate if the ‘temporary’ lull in the growth and inflation data proves more long-lasting. As has been said elsewhere, while the bar for cutting rates is high, the bar for raising rates is much, much higher. The next move is almost certainly lower.

And what has caused this evolution in thought since the last FOMC meeting? Well, the obvious answers are, first, the sharp escalation in the trade war, with the US raising tariffs on $200B of Chinese imports from 10% to 25% as well as threatening to impose that level of tariffs on the other $325B of Chinese imports. And second, the fact that the Brexit story has spiraled out of control, with further cabinet resignations (today Andrea Leadsom, erstwhile leader of the Tories in the House of Commons quit the Cabinet) adding to pressure on PM May to resign and opening up the potential for a hardline Boris Johnson to become the next PM and simply pull the UK out of the EU with no deal.

In fact, while I have written consistently on both topics over the past several months, the Fed remained the top driver previously. But now, these events are clearly completely outside the control of monetary officials and markets are going to respond to them as they unfold. In other words, look for more volatility, not less going forward.

With that as a backdrop, it can be no surprise that risk is being jettisoned across the board this morning. Equity markets are down around the world (Shanghai -1.4%, Nikkei -0.6%, DAX -1.75%, FTSE -1.4%, DJIA futures -0.9%, Nasdaq futures -1.25%); Treasuries (2.35%) and Bunds (-0.11%) are both in demand with yields falling; and the dollar is back on top of the world, with the yen along for the ride. A quick survey of G10 currencies shows the euro -0.15% and back to its lowest level since May 2017, the pound -0.2% extending its losing streak to 13 consecutive down days, while Aussie and Canada are both lower by 0.25%.

In the emerging markets, despite the fact that the PBOC continues to fix the renminbi stronger than expected, and still below 6.90, the market will have none of it and CNY is lower by a further 0.2% this morning and back above 6.94. Despite higher oil prices RUB and MXN are both softer by 0.6% and 0.4% respectively. CE4 currencies are under pressure with HUF leading the way, -0.4%, but the rest down a solid 0.25%-0.3%. In other words, there is no place to hide.

The hardest thing for risk managers to deal with is that these events are completely unpredictable as they are now driven by emotions rather than logical economic considerations. As such, the next several months are likely to see a lot of sharp movement on each new headline until there is some resolution on one of these issues. Traders and investors will be quite relieved when that happens, alas I fear it will be mid-summer at the earliest before anything concrete is decided. Until then, rumors and stories will drive prices.

Turning to today’s session we see a bit of US data; Initial Claims (exp 215K) and New Home Sales (675K). Tuesday’s Existing Home Sales disappointed and represented the 14th consecutive month of year-on-year declines. Of more interest, we have four Fed speakers (Kaplan, Barkin, Bostic and Daly) at an event and given what I detect is the beginnings of a change in view, these words will be finely parsed. So, at this point the question is will the fear factor outweigh the possible beginning of a more dovish Fed narrative. Unless all four talk about the possibility of cutting rates as insurance, I think fear still reigns. That means the dollar’s recent climb has not ended.

Good luck
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Mostly Mayhem

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There once was a female PM
Whose task was the fallout, to stem,
From Brexit, alas
What then came to pass
Was discord and mostly mayhem

And so, because progress has lumbered
Theresa May’s days are now numbered
The market’s concern
Is Boris can’t learn
The problems with which he’s encumbered

In the battle for headline supremacy, at least in the FX market’s eyes, Brexit has once again topped the trade war today. The news from the UK is that PM May has now negotiated her own exit which will be shortly after the fourth vote on her much-despised Brexit bill in Parliament. The current timing is for the first week of June, although given how fluid everything seems to be there, as well as a politician’s preternatural attempts to retain power, it may take a little longer. However, there seems to be virtually no possibility that the legislation passes, and Theresa May’s tumultuous time as PM seems set to end shortly.

Of course, that begs the question, who’s next? And that is the market’s (along with the EU’s) great fear. It appears that erstwhile London Mayor, Boris Johnson, is a prime candidate to win the leadership election, and his views on Brexit remain very clear…get the UK out! In the lead up to the original March 31 deadline, you may recall I had been particularly skeptical of the growing sentiment at the time that a hard Brexit had been taken off the table. In the end, the law of the land is still for the UK to leave the EU, deal or no deal, now by October 31, 2019. It beggars belief that the EU will readily reopen negotiations with the UK, especially a PM Johnson, and so I think it is time to reassess the odds of the outcome. Here is one pundit’s view:

  May 16, 2019 May 17, 2019
Soft Brexit 50% 20%
Vote to Remain 30% 35%
Hard Brexit 20% 45%

Given this change in the landscape, it can be no surprise that the pound continues to fall. This morning sees the beleaguered currency lower by a further 0.3% taking the move this month to 3.2%. And the thing is, given the nature of this move, which has been very steady (lower in 9 of the past 10 sessions with the 10th unchanged), there is every reason to believe that this has further room to run. Very large single day moves tend to be reversed quickly, but this, my friends is what a market repricing future probability looks like. The most recent lows, near 1.25 in December look a likely target at this time.

Of course, the fact that the market seems more focused on Brexit than trade doesn’t mean the trade story has died. In fact, equity markets in Asia suffered, as have European ones, on the back of comments from the Chinese Commerce Ministry that no further talks are currently scheduled, and that the Chinese no longer believe the US is negotiating in good faith. As such, risk is clearly being reduced across the board this morning with not merely equity weakness, but haven strength. Treasury (2.37%) and Bund (-0.11%) yields continue to fall while the yen (+0.2%) rallies alongside the dollar.

In FX markets, the Chinese yuan has fallen again (-0.3%) and is now trading at 6.95, quite close to the supposed critical support (dollar resistance) level of 7.00. There continues to be a strong belief in the market, along with the analyst community, that the PBOC won’t allow the renminbi to weaken past that level. This stems from market activity in 2015, when the Chinese surprised everyone with a ‘mini-devaluation’ of 1.5% one evening in early August of that year. The ensuing rush for the exits by Chinese nationals trying to save their wealth cost the PBOC $1 trillion in FX reserves as they tried to moderate the renminbi’s decline. Finally, when it reached 6.98 in late December 2016, they changed the capital flow regulations and added significant verbal suasion to their message that they would not allow the currency to fall any further.

And for the most part, it worked for the next 15 months. However, clearly the situation has changed given the ongoing trade negotiations, and arguably given the deterioration in the relationship between the US and China. While the Chinese have pledged to avoid currency manipulation, it is not hard to argue that their current activities in maintaining yuan strength are just that, manipulation. Given the capital controls in place, meaning locals won’t be able to rush for the doors, it is entirely realistic to believe the PBOC could say something like, ‘we believe it is appropriate for the market to have a greater role in determining the value of the currency and are widening the band around the fix to accommodate those movements.’ A 5% band would certainly allow a much weaker renminbi while remaining within the broad context of their policy tools. In other words, I am not convinced that 7.00 is a magic line, perhaps more like a Maginot Line. If your hedging policy relies on 7.00 being sacrosanct, it is time to rethink your policy.

Overall, the dollar is firmer pretty much everywhere, with yesterday’s broad strength being modestly extended today. Yesterday’s US data was much better than expected as Housing starts grew 5.6% and Philly Fed printed at a higher than expected 16.6. Later this morning we see the last data of the week, Michigan Sentiment (exp 97.5). We also hear from two more Fed speakers, Clarida and Williams, although we have already heard from both of them earlier this week. Yesterday Governor Brainerd made an interesting series of comments regarding the Fed’s attempts to lift inflation, highlighting for the first time, that perhaps their models aren’t good descriptions of the economy any more. After a decade of inability to manage inflation risk, it’s about time they question something other than the market. While I am very happy to see them reflecting on their process, my fear is they will conclude that permanent easy money is the way of the future, a la Japan. If that is the direction in which the Fed is turning, it will have a grave impact on the FX markets, with the dollar likely to suffer the most as the US is, arguably, the furthest from that point right now. But that is a future concern, not one for today.

Good luck and good weekend
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“Talks” Become “War”

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At what point do “talks” become “war”?
And how long can traders ignore
The signs that a truce
Are, at best, abstruse?
It seems bulls don’t care any more

So, markets continue to shine
But something’s a bit out of line
If problems have past
Then why the forecast
By bonds of a further decline

I can’t help being struck this morning by the simultaneous rebound in equity markets alongside the strong rally in bond markets. They seem to be telling us conflicting stories or are perhaps simply focusing on different things.

After Monday’s equity market rout set nerves on edge, and not just among the investor set, but also in the White House, it was no surprise to hear a bit more conciliatory language from the President regarding the prospects of completing the trade negotiations successfully. That seemed to be enough to cool the bears’ collective ardor and brought bargain hunters dip buyers back into the market. (Are there any bargains left at these valuations?) This sequence of events led to a solid equity performance in Asia despite the fact that Chinese data released last night was, in a word, awful. Retail Sales there fell to 7.2%, the lowest in 16 years and well below forecasts of 8.6% growth. IP fell to 5.4%, significantly below the 6.5% forecast, let alone last month’s 8.5% outturn. And Fixed Asset Investment fell to 6.1%, another solid miss, with the result being that April’s economic performance in the Middle Kingdom was generally lousy. We have already seen a number of reductions in GDP forecasts for Q2 with new expectations centering on 6.2%.

But the market reaction was not as might have been expected as the Shanghai composite rose a solid 1.9%. It seems that China is moving into the ‘bad news is good’ scenario, where weak data drives expectations of further monetary stimulus thus supporting stock prices. The other interesting story has been the change in tone in the official Chinese media for domestic Chinese consumption, where they have become more stridently nationalist and are actively discussing a trade “war”, rather than trade “talks”. It seems the Chinese are girding for a more prolonged fight on the trade front and are marshaling all the resources they can. Of course, at the end of the day, they remain vulnerable to significant pain if the second set of tariffs proposed by the US is enacted.

One consequence of this process has been a weakening Chinese yuan, which has fallen 2.7% since its close on Friday May 3rd, and is now at its weakest point since mid-December. At 6.9150 it is also less than 2% from the 7.00 level that has been repeatedly touted by analysts as a no-go zone for the PBOC. This is due to concerns that the Chinese people would be far more active in their efforts to protect their capital by moving it offshore. This is also the reason there are such tight capital flow restrictions in China. It doesn’t help the trade talks that the yuan has been falling as that has been a favorite talking point of President Trump, China’s manipulation of their currency.

This process has also renewed pundit talk of the Chinese selling all their Treasury holdings, some $1.1 trillion, as retaliation to US tariffs. The last idea makes no sense whatsoever, as I have mentioned in the past, if only because the question of what they will do with $1.1 trillion in cash has yet to be answered. They will still need to own something and replacing Treasuries with other USD assets doesn’t achieve anything. Selling dollars to buy other currencies will simply weaken the dollar, which is the opposite of the idea they are trying to manipulate their currency to their advantage, so also makes no sense. And finally, given the huge bid for Treasuries, with yields on the 10-year below 2.40%, it seems there is plenty of demand elsewhere.

Speaking of the Treasury bid, it seems bond investors are looking ahead for weaker overall growth, hence the declining yields. But how does that square with equity investors bidding stocks back up on expectations that a trade solution will help boost the economy. This is a conundrum that will only be resolved when there is more clarity on the trade outcome.

(Here’s a conspiracy theory for you: what if President Trump is purposely sabotaging the talks for now, seeking a sharp enough equity market decline to force the Fed to ease policy further. At that point, he can turn around and agree a deal which would result in a monster rally, something for which we can be sure he would take credit. I’m not saying it’s true, just not out of the question!)

At any rate, nothing in the past several sessions has changed the view that the trade situation is going to continue to be one of the key drivers for market activity across all markets for the foreseeable future.

After that prolonged diatribe, let’s look at the other overnight data and developments. German GDP rose 0.4%, as expected, in Q1. This was a significant uptick from the second half of last year but appears to be the beneficiary of some one-off issues, with slower growth still forecast for the rest of the year. Given expectations were built in, the fact that the euro has softened a bit further, down 0.1% and back below 1.12, ought not be too surprising. Meanwhile, the pound is little changed on the day, but has drifted down to 1.2900 quietly over the past two sessions. Despite solid employment data yesterday, it seems that traders remain unconvinced that a viable solution will be found for Brexit. This morning the word is that PM May is going to bring her thrice-defeated Brexit deal to Parliament yet again in June. One can only imagine how well that will go.

Elsewhere in the G10 we have the what looks like a risk-off session. The dollar is modestly stronger against pretty much all of that bloc except for the yen (+0.2%) and the Swiss franc (+0.1%), the classic haven assets. So, bonds (Bund yields are -0.10%, their lowest since 2016) and currencies are shunning risk, while equity traders continue to lap it up. As I said, there is a conundrum.

This morning we finally get some US data led by Retail Sales (exp 0.2%, 0.7% ex autos) as well as Empire Manufacturing (8.5), IP (0.0%) and Capacity Utilization (78.7%) all at 8:30. Business Inventories (0.0%) are released at 10:00 and we also hear from two more Fed speakers, Governor Quarles and Richmond Fed President Barkin. However, it seems unlikely that, given the consistency of message we have heard from every Fed speaker since their last meeting, with Williams and George yesterday reinforcing the idea that there is no urgency for the Fed to change policy in the near term and politics is irrelevant to the decision process, that we will hear anything new from these two.

In the end, it feels like yesterday’s equity rebound was more dead-cat than a start of something new. Risks still abound and slowing economic growth remains the number one issue. As long as US data continues to outperform, the case for dollar weakness remains missing. For now, the path of least resistance is for a mildly firmer buck.

Good luck
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Still Feeling Stressed

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The overnight data expressed
That China is still feeling stressed
But Europe’s reports
Showed growth of some sorts
Might finally be manifest

The dollar is on its heels this morning after data from Europe showed surprising strength almost across the board. Arguably the most important data point was Eurozone GDP printing at 0.4% in Q1, a tick higher than expected and significantly higher than Q4’s 0.2%. The drivers of this data were Italy, where Q1 GDP rose 0.2%, taking the nation out of recession and beating expectations. At the same time Spain grew at 0.7%, also better than expectations while France maintained its recent pace with a 0.3% print. Interestingly, Germany doesn’t report this data until the middle of May. However, we did see German GfK Consumer Confidence print at 10.4, remaining unchanged on the month rather than falling as expected. Adding to the growth scenario were inflation readings that were generally a tick firmer than expected in Italy, Spain and France. While these numbers remain well below the ECB target of “close to but just below” 2.0%, it has served to ease some concerns about Europe’s future. In the end, the euro has rallied 0.25% while European government bond yields are all higher by 2-5bps. However, European equity markets did not get the memo and remain little changed on the day.

Prior to these releases we learned that China’s PMI data was softer than expected, with the National number printing lower at 50.1, while the Caixin number printed at 50.2. Even though both remain above the 50.0 level indicating future growth, there is an increasing concern that China’s Q1 GDP data was more the result of a distorted comparison to last year’s data due to changed timing of the Lunar New Year. Remember, that holiday has a large impact on the Chinese economy with manufacturing shutdowns amid widescale holiday making, and so the timing of those events each year are not easily stabilized with seasonal adjustments to the data. As such, it is starting to look like Q1’s 6.4% GDP growth may have been somewhat overstated. Of course, China remains opaque in many ways, so we may need to wait until next month’s PMI data to get a better handle on things. One other clue, though, has been the ongoing decline in the price of copper, a key industrial metal and one which China represents approximately 50% of global demand. Arguably, a falling copper price implies less demand from China, which implies slowing growth there. Ultimately, while it is no surprise that the renminbi is little changed on the day, Chinese equities edged higher on the theory that the PBOC is more likely to add stimulus if the economic slowdown persists.

Of course, the other China story is that the trade talks are resuming in Beijing today and market participants will be watching closely for word that things are continuing to move in the right direction. You may recall the President Xi Jinping gave a speech last week where he highlighted the changes he anticipated in Chinese policy, all of which included accession to US demands in the trade talks. At this point, it seems the negotiators need to “simply” hash out the details, which of course is not simple at all. But if the direction from the top is broadly set, a deal seems quite likely. However, as I have pointed out in the past, the market appears to have already priced in the successful conclusion of a deal, and so when (if) one is announced, I would expect equity markets to fall on a ‘sell the news’ response.

Turning to the US, yesterday’s data showed that PCE inflation (1.5%, core 1.6%) continues to lag expectations as well as remain below the Fed’s 2.0% target. With the FOMC meeting starting this morning, although we won’t hear the outcome until tomorrow afternoon, the punditry is trying to determine what they will say. The universal expectation is for no policy changes to be enacted, and little change in the policy statement. However, to me, there has been a further shift in the tone of the most recent Fed speakers. While I believe that Loretta Mester and Esther George remain monetary hawks, I think the rest of the board has morphed into a more dovish contingent, one that will respond quite quickly to falling inflation numbers. With that in mind, yesterday’s readings have to be concerning, and if we see another set of soft inflation data next month, it is entirely possible that the doves carry the day at the June meeting and force an end to the balance sheet roll-off immediately as a signal that they will not let inflation fall further. I think the mistake we are all making is that we keep looking for policy normalization. The new normal is low rates and growing balance sheets and we are already there.

As Powell and friends get together
The question is when, it’s not whether
More policy easing
Will seem less displeasing
So prices can rise like a feather

Looking at this morning’s releases, the Employment Cost Index (exp 0.7%) starts us off with Case-Shiller home prices (3.2%) and then Chicago PMI (59.0) following later in the morning. However, with the Fed meeting ongoing, it seems unlikely that any of these numbers will move the needle. In fact, tomorrow’s ADP number would need to be extraordinary (either high or low) to move things ahead of the FOMC announcement. All this points to continued low volatility in markets as players of all stripes try to figure out what the next big thing will be. My sense is we are going to see central banks continue to lean toward easier policy, as the global focus on inflation, or the lack thereof, will continue to drive policy, as well as asset bubbles.

Good luck
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A Victimless Crime

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Investors are biding their time
Til GDP data sublime
But what if it’s weak?
Will havoc it wreak?
Or is that a victimless crime?

In general, nothing has really happened in markets overnight. Perhaps the only exception is the continued weakness in the Shanghai Composite, which fell another 1.2%, taking the week’s decline beyond 5%. But otherwise, most equity markets are little changed, currencies have done little, and bond yields are within 1 bp of yesterday’s closes as well. The blame for this inactivity is being laid at the feet of this morning’s US GDP data, where we get our first look at Q1. What is truly interesting about this morning’s number is the remarkably wide range of expectations according to economist surveys. They range from 1.0% to 3.2% and depending on your source, I have seen median expectations of 2.0% (Tradingeconomics.com), 2.2% (Bloomberg) and 2.5% (WSJ). The problem with such a wide range is it will be increasingly difficult to determine what is perceived as strong or weak when it prints. However, my view is that we are in the middle of a market narrative which dictates that a strong print (>2.5%) will see equity and dollar strength on the back of confidence in the US economy continuing its world leading growth, while a weak number (<2.0%) will lead to equity strength but dollar weakness as traders will assume that given the Fed’s recent dovish turn, expectations for rate cuts will grow and stocks will benefit accordingly while the dollar suffers. We’ll know more pretty soon.

Returning to the China story, there are actually two separate threads of discussion regarding the Chinese markets and economy. The first, which has been undermining equities there this week, is that the PBOC is backing off on its recent easing trajectory, slowing the injection of short-term funds into the market. The massive equity market rally that we have seen there so far this year has been fueled by significant margin buying, however, if easy money is ending then so will the rally. While I am certain the PBOC will do all it can to prevent a major correction in stock prices, the tone of discussion there is that the PBOC is no longer supporting a further rise.

The second part of the story was a speech last night by President Xi regarding the Belt and Road Initiative. In it, he basically acceded to the US demands for honoring IP, ending forced technology transfer and maintaining a stable currency. Adding to that was the PBOC’s fix at a stronger than expected rate of 6.7307, reinforcing the idea that they would not seek advantage by weakening their currency. Given that the renminbi has been weakening steadily for the past seven sessions and reached its weakest point in more than two months, the PBOC’s actions have served to reinforce their desire to maintain control of the currency.

But arguably, the more important part of the speech was that it cleared the way, at the highest levels, for the Chinese to agree to numerous US demands on trade, and thus successfully conclude the trade talks. Those talks get going again next week when Mnuchin and Lighthizer travel back to Beijing. Look for very positive vibes when they meet the press.

Given that one of the key constraints in the global economy lately has been trade concerns, led by the US-China spat, a resolution will be seen as a harbinger to deals elsewhere and the removal of at least one black cloud. Will central banks then return to their tightening efforts? I sincerely doubt that we will see anything of the sort in the near term. At this point, I expect the reaction function for the central banking community is something along the lines of, ‘we will raise rates after we see inflation print at high levels for several consecutive months, not in anticipation that higher inflation is coming because of growth in another variable.’

So despite my earlier concerns that the market had already priced in a successful conclusion of the trade deal, and that when it was signed, equity markets would retreat, it now seems more likely that we have further to run on the upside. Central banks are nowhere near done blowing all their bubbles.

And those are the big stories for the day. As well as the GDP data at 8:30 we get Michigan Sentiment at 10:00 (exp 97.0), although that seems unlikely to have any impact after GDP. The dollar has had a hell of a week, rallying steadily as we continue to see weak data elsewhere (Japanese IP -4.6% last night!), and some emerging markets, notably ARS and TRY have come under significant new pressure. It wouldn’t surprise if there was some profit taking after the data, whether strong or weak, so I kind of expect the dollar to fade a little as we head into the weekend.

Good luck and good weekend
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Spring Next Year

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Interest rates shan’t
Rise ere spring next year. But might
They possibly fall?

This morning’s market theme is that things look bad everywhere, except perhaps in the US. Starting in Tokyo, the BOJ met last night and, to no one’s surprise, left their policy rate unchanged at -0.10%. They maintained their yield curve control target of 0.00% +/- 0.20% for 10-year JGB’s and they indicated they would continue to purchase JGB’s at a clip of ¥80 trillion per year. But there were two things they did change, one surprising and one confusing.

First the surprise; instead of claiming rates would remain low for an “extended period”, the new language gave a specific date, “at least through around spring 2020”. Of course, this gives them the flexibility to extend that date specifically, implying an even more dovish stance going forward. Market participants were not expecting any change to the language, but interestingly, the yen actually rallied after the report. Part of that could be because there was significant weakness in Asian equity markets and a bit of a risk-off scenario, but I also read that some analysts see this as a prelude to tighter policy. I don’t buy the latter idea, but it does have adherents. The second thing they did, the confusing one, was they indicated they would create a lending facility for their ETF portfolio. The unusual thing here is that generally, lending securities is a way to encourage short-selling, although they did couch the idea in terms of added liquidity to the market. Given they own more than 70% of the ETF market, it is clear that liquidity must be suffering, but I wouldn’t have thought bringing short-sellers to the party would be their goal.

In South Korea, Q1 GDP shrank -0.3%, a much worse outcome than the expected 0.3% growth, and largely caused by a sharp decline in exports and IP. This is an ominous sign for the global economy, and also calls into question the accuracy of the Chinese data last week. Given the tight relationship between Korean exports and Chinese growth, something seems out of place here. The market impact was a decline in the KOSPI (-0.5%), falling Korean yields and a decline in the KRW, which fell a further 0.6% and is now at its weakest point in two years. Look for the Bank of Korea to ease policy going forward.

Turning to Europe, the Swedish Riksbank left policy rates unchanged at -0.25%, as expected, but their statement indicated that there would be no rate hike later this year, as previously expected, given the slowing growth and lack of inflation in Sweden. While I foreshadowed this earlier this week, the market response was severe, with SEK falling 1.4%, although the Swedish OMX (stock market) rallied 1% on the news. You know, bad news is good because rates remain low.

One last central bank note, the Bank of Canada has thrown in the towel on normalizing policy, dropping any reference to higher rates in the future from their statement yesterday. Upon the release of the statement, the Loonie fell a quick 1%. Although it has since recovered a bit of that, it is still lower by 0.6% from before the meeting. It seems concerns over slowing growth now outweigh concerns over excess leverage in the private sector.

The other market note was the sharp decline in Chinese stocks with the Shanghai Composite falling 2.4% as traders and investors there lose faith that the PBOC is going to continue to support the economy, especially after the better than expected GDP data last week. Even the renminbi fell, -0.3%, although it has been especially stable for the past two months as the US-China trade talks continue. Speaking of which, the next round of face-to-face talks are set to get under way shortly, but there has been little in the way of news, either positive or negative, for the past two weeks.

One other thing about which we have not heard much lately is Brexit, where the internal political machinations continue in Parliament, but as yet, there has been no willingness to compromise on either side of the aisle. Of note is that the pound continues to fall, down a further 0.2% this morning and now firmly below 1.29. While there is no doubt that the dollar is strong across the board, it also strikes that some market participants are beginning to price in a chance of a no-deal Brexit again, despite Parliament’s stated aim of preventing that. As yet, there is no better alternative.

Finally, the euro is still under pressure this morning as well, down a further 0.2% this morning, which makes 1.5% in the past week. This morning’s only data point showed Unemployment in Spain rose unexpectedly to 14.7%, another sign of slowing growth throughout the Eurozone. At this point, the ECB is unwilling to commit to easing policy much further, but with the data misses piling up, at some point they are going to concede the point. Easier money is coming to the Eurozone as well.

This morning brings Initial Claims data (exp 200K) and Durable Goods (0.8%, 0.2% ex Transport). It doesn’t seem that either of these will change any views, and as we have seen all week, I expect that Q1 earnings will be the market’s overall focus. A bullish spin will continue to highlight the different trajectories of the US and the rest of the world, and ultimately, continue to support the dollar.

Good luck
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Addiction To Debt

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A policy change did beget
In China, addiction to debt
Per last night’s report
Financial support
Continues, the bulls’ views, to whet

The data from China continues to surprise modestly to the upside. Last week, you may recall, the Manufacturing PMI report printed above 50 in a surprising rebound. Last night, Q1 GDP printed at 6.4%, a tick better than expected, and the concurrent data; Fixed Asset Investment (6.3%), IP (8.5%) and Retail Sales (8.7%) all beat expectations as well. In fact, the IP data blew them away as the analyst community was looking for a reading of 5.9%. While there is some possibility that the data is still mildly distorted from the late Lunar New Year holiday, it certainly seems as though the Chinese have managed to prevent any significant further weakness in their economy.

How, you may ask, have they accomplished this feat? Why the way every government does these days. As we also learned last week, debt in China continues to grow rapidly, far more rapidly than the economy, which means that every yuan of debt buys less growth. It should be no surprise that there is diminishing effectiveness in this strategy, but it should also be no surprise that this is likely to be the way forward. In the short run, this process certainly pads the data story, helping to ensure that growth continues. However, there is a clear and measurable negative aspect to this policy.

Exhibit A is real estate. One of the areas seeing the most investment in China continues to be real estate. The problem with expanding real estate debt (it grew 11.6% in Q1 compared to 6.4% growth for GDP) is that real estate investment is not especially productive. For an economy that relies on manufacturing, productivity growth is crucial. The more money invested in real estate, the less available for improved efficiencies in the economy. Longer term this will lead to slower GDP growth in China, just as it has done in all the developed world economies. However, as politics, even in China, is based on the here and now, there is no reason to expect these policies to change. Two years ago, President Xi tried to force a crackdown on excessive debt used to finance the property bubble that had inflated throughout China. However, it is abundantly clear that the priorities have shifted to growth at all costs. At this stage, I expect that we will see consistently better numbers out of China going forward, regardless of any trade resolution. If Xi wants growth, that is what the rest of the world will see, whether it exists or not.

Turning to the FX market, this implies to me that we are about to see CNY start to strengthen further. Last night saw a 0.40% rally taking the dollar down to key support levels between 6.68-6.69. I expect that we are going to see the renminbi start a more protracted move higher and at this point would not be surprised to see the USDCNY end 2019 around 6.30. That is a significant change in my view from earlier this year, but there has also been a significant change in the policy stance in China which cannot be ignored.

Elsewhere, risk overall has been ‘on’ as investors have responded to the better than expected Chinese data, as well as the continued dovishness from the central banking community, and keep buying stocks. If you recall several weeks ago, there was a conundrum as both stocks and bonds were rallying. At the time, the view from most pundits was that the stock market was wrong and that the bond market was presaging a significant slowdown in the economy. In fact, we saw that first yield curve inversion at the time in early March. However, since then, 10-year Treasury yields have backed up by 22bps and now sit above 2.60% for the first time in a month, while stock prices have continued to rally. As such, it appears that the bond market had it wrong, not the stock market. The one caveat is that this stock market rally has been on diminishing volumes which implies that it is not that widely supported. The opposing viewpoints are the bulls believe there is a big catch up rally in the wings as those who have missed out reach peak FOMO, while the bears believe that though the rally has been substantial, it has a very weak underlying basis, and will retreat rapidly.

As to the FX market, yesterday saw dollar strength, which was a bit surprising given the weaker than expected economic data (both IP and Capacity Utilization disappointed) as well as mixed to negative earnings data from the equity market. However, this morning, the dollar has retraced those gains with the pound being the one real outlier, falling slightly amid gains in virtually every other currency, as inflation data from the UK printed softer than expected at 1.9%, thus pushing any concept of tighter policy even further into the future.

On the data front, this morning brings the Trade Balance (exp -$53.3B) and then the Fed’s Beige Book is released this afternoon. We also have two more Fed speakers, Harker and Bullard, but that message remains pretty consistent. No change in policy in the near future and all efforts to determine the best way to push inflation up to the target level. What this means in practice is that there is a vanishingly small probability that US monetary policy will tighten any further in the near future. Of course, neither will policy elsewhere tighten, so I continue to view the dollar’s prospects positively with the clear exception of the CNY as mentioned above.

Good luck
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Clearly On Hold

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Though policy’s clearly on hold
Most central banks feel they’ve controlled
The story on growth
And yet they’re still loath
To change their inflation threshold

Amidst generally dull market activity (at least in the FX market), traders and investors continue to look for the next key catalysts to drive markets. In US equity markets, we are now entering earnings season which should keep things going for a while. The early releases have shown declining earnings on a sequential basis, but thus far the results have bested estimates so continue to be seen as bullish. (As an aside, could someone please explain to me the bullish case on stocks trading at a 20+ multiple with economic growth in the US at 2% and globally at 3.5% alongside extremely limited policy leeway for further monetary ease? But I digress.) Overnight saw Chinese stocks rock, with Shanghai soaring 2.4% and the Hang Seng 1.1%. European stocks are a bit firmer as well (DAX +0.6%, FTSE +0.4%) and US futures are pointing higher.

Turning to the central banks, we continue to hear the following broad themes: policy is in a good place right now, but the opportunity for further ease exists. Depending on the central bank this is taking different forms. For example, the Minutes of the RBA meeting indicated a growing willingness to cut the base rate further, and market expectations are building for two more cuts this year, down to 1.00%. Meanwhile, the Fed has no ability to cut rates yet (they just stopped raising them in December) but continues to talk about how they achieve their inflation target. Yesterday, Boston Fed president Rosengren posited that a stronger commitment to the symmetry around their 2.0% target could be useful. Personally, I don’t believe that, but I’m just a gadfly, not a PhD economist. At any rate, the idea is that allowing the economy to run hot without tightening is tantamount to easing policy further. In the end, it has become apparent the Fed’s (and every central bank’s) problem is that their economic models no longer are a good representation of the inner workings of the economy. As such, they are essentially flying blind. Previous relationships between growth, inflation and employment have clearly changed. I make no claim that I know what the new relationships are like, just that 10 years of monetary policy experiments with subpar results is enough to demonstrate the central banks are lost.

This is true not just in the US and Europe, but in Japan, where they have been working on QE for nearly thirty years now.

More ETF’s bought
Will be followed by more and
More ETF’s bought

“It’s vital for the Bank of Japan to continue persistently with powerful monetary easing,” Governor Haruhiko Kuroda said. As can be seen from Kuroda-san’s comments last night in the Diet, the BOJ is a one-trick pony. While it is currently illegal for the Fed to purchase equities, that is not the case in Japan, and they have been buying them with gusto. The thing is, the Japanese economy continues to stumble along with minimal growth and near zero inflation. As the sole mandate for the BOJ is to achieve their 2.0% inflation target, it is fair to say that they have been failing for decades. And yet, they too, have not considered a new model.

In the end, it seems the lesson to be learned is that the myth of omnipotence that the central banks would have us all believe is starting to crack. Once upon a time central banks monitored activity in the real economy and tried to adjust policy accordingly. Financial markets followed their lead and responded to those actions. But as the world has become more financially oriented during the past thirty years, it seems we now have the opposite situation. Now, financial markets trade on anticipation of central bank activity, and if central banks start to tighten policy, financial markets tend to throw tantrums. However, there is no tough love at central banks. Rather they are indulgent parents who cave quite quickly to the whims of declining markets. Regardless of their alleged targets for inflation or employment, the only number that really matters is the S&P 500, and that is generally true for every central bank.

Turning to this morning’s data story, the German ZEW survey was released at a better than expected 3.1. In fact, not only was this better than forecast, but it was the first positive reading in more than a year. It seems that the ongoing concerns over German growth may be easing slightly at this point. Certainly, if we see a better outcome in the Manufacturing PMI data at the end of April, you can look for policymakers to signal an all clear on growth, although they seem unlikely to actually tighten policy. Later this morning we see IP (exp 0.2%) and Capacity Utilization (79.1%) and then tonight, arguably more importantly, we see the first look at Chinese Q1 GDP (exp 6.3%).

If you consider the broad narrative, it posits that renewed Chinese monetary stimulus will prevent a significant slowdown there, thus helping economies like Germany to rebound. At the same time, the mooted successful conclusion of the US-China trade talks will lead to progress on US-EU and US-Japanese talks, and then everything will be right with the world as the previous world order is reincarnated. FWIW I am skeptical of this outcome, but clearly equity market bulls are all-in.

In the end, the dollar has been extremely quiet (volatility measures are back to historic lows) and it is hard to get excited about movement in the near-term. Nothing has yet changed my view that the US will ultimately remain the tightest policy around, and thus continue to draw investment and USD strength. But frankly, recent narrow ranges are likely to remain in place for a little while longer yet.

Good luck
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A Future Upgrade

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The data from China conveyed
A story that can be portrayed
As Q1 was weak
But policy tweaks
Imply there’s a future upgrade

In a relatively dull session for news events, Chinese data was the biggest story. The trade surplus there expanded dramatically, rising to $32.6B, much larger than any expectations, as not only did exports grow more robustly (+14.2%) but imports fell sharply (-7.6%). On the surface this suggests that the global situation may have seen its worst days, as demand for Chinese goods was strong, but the domestic economy there continues to be plagued by weakness. However, a few hours later, Chinese money supply and loan data was released with a slightly different message. Here, M2 grew more than expected at an 8.6% rate, while new loans also expanded sharply (+13.7%) implying that the PBOC’s efforts at stimulating the economy are starting to bear fruit. The loan data also implies that growth going forward, in Q2 and beyond, is likely to rebound further. In fact, the only negative piece of news was that auto sales continue to decline in China, falling 5.2% in March, the ninth consecutive year/year decline in the series. The market response to this was muted in the equity space, with Shanghai virtually unchanged, but the renminbi did benefit, rising 0.2% in the wake of the release.

Away from those data points, the news has been sparse. Interestingly, the dollar has been under pressure across the board since yesterday’s close with the euro now higher by 0.6%, both the pound and yen by 0.3% and Aussie leading the way amid firmer commodity prices, by 0.7%. In fact, despite the Shanghai equity performance, today has all the other earmarks of a risk-on session. Equity markets elsewhere in Asia were firm (Nikkei +0.75%, Hang Seng +0.25%), they are higher in Europe (FTSE and CAC +0.4%, DAX +0.6%) and US futures are pointing higher as well (DJIA +0.7%, S&P +0.5%). At the same time government bond yields are rising with 10-year Treasury yields now higher by 5bps. Much of this movement has occurred early this morning after JP Morgan released better than expected results. So, for today, all seems right with the world!

Away from those data releases, there has been far less of interest. Yesterday we heard from NY Fed President Williams who explained that the rate situation was appropriate for now and that there was no reason for the Fed to act in the near future. While growth seems solid, the continuing lack of measured inflation shows no signs of changing and so rates are likely to remain on hold for an extended period. In a related story, a WSJ survey of economists described this morning shows expectations for the next Fed move to have been pushed back to Q4 2020, with a growing likelihood that it will be a rate cut. In other words, expectations are for an extended period of time with no monetary policy changes. If that is the case, then markets will need to find other catalysts to drive prices. Who knows, maybe equity prices will start to reflect company fundamentals again! Just kidding!

Actually, this situation will drive the market to be even more focused on the economic data as essentially every central bank around the world has indicated the current policy pause is designed to observe the data and then respond accordingly. So, if weakness becomes evident in a country or region, look for the relevant central bank(s) to ease policy quickly. At the same time, if inflation does start to pick up someplace, policy tightening will be discussed, if not implemented right away. And markets will respond to these discussions given the lack of other catalysts.

For now however, Goldilocks has been revived. Rates have almost certainly peaked for this cycle, and policy stability may well lead us to yet further new highs in the equity space. Perhaps the central banks have well and truly killed the business cycle and replaced it with a permanent modest growth trajectory. Personally, I don’t believe that is the case, as evidenced by the diminishing impact of each of their policies, but the evidence over the past several years is working in their favor, I have to admit.

This morning’s only data point is Michigan Consumer Sentiment, which is expected to decline slightly from last month’s 98.4 to 98.0 today. We also hear from Chair Powell again, but that story is old news. With risk being acquired, look for the dollar to continue to falter for the rest of the session, albeit probably not by much more. Things haven’t changed that much!

Good luck and good weekend
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